Sunday, March 13, 2016

Here's an attempt to describe the Algo Trading business in layman's terms. Let's split the phrase into words - 'Algo' and 'Trading'. As you may already know, the word 'Trading' here stands for the action of buying and selling stocks in the capital markets. The another word 'Algo' here stands for the term 'Algorithmic'. If you already know what an algorithm is, you can skip the next paragraph.

An algorithm is a clearly defined step-by-step set of operations to be performed. Let's say if you are assigned a task to drink water from a bottle, the algorithm or set of operations for that will be - to get the water bottle, open the cap, drink the water, close the cap and place the bottle at the right place. Simple. Similarly in a computer system, when you need a machine to do something for you, you explain it the job clearly by setting instructions for it to execute. And that process is also called 'programming a computer'.

Now, many of you might already know that before the electronic trading took over, the stock trading was mainly a paper-based activity. There were actual stock certificates and one needed to be physically present there to buy or sell stocks. You can read what was it like to trade before electronic trading took over. And then there was dematerialization (DEMAT). Actual certificates were slowly being replaced by their electronic form as they could be registered or transferred electronically. It increased the fluctuations in the stock-prices because now the trading process was faster. But then with the technological developments came the next big thing - ALGO TRADING. Now, you can write an algorithm and instruct a computer to buy or sell stocks for you when the defined conditions are met. These programmed computers can trade at a speed and frequency that is impossible for a human trader. This process can be semi-automated or completely automated and this is why the terms automated trading and algo trading are used interchangeably. But there is a small difference between algo trading and automated trading.

If you are an experienced stock trader with a trading strategy, you can best utilize the algo trading by setting instructions for a computer (write an algorithm) to trade when the defined conditions are met.Knowledge of technical analysis of stocks/trades plays an important role in developing a profitable trading strategy. Technical analysis is academic study of chart patterns and trends of publicly traded stocks. Soon, I will provide content here to help you understand the technical analysis. Feel free to comment! Cheers!

Wednesday, March 9, 2016

Many traders use the terms algorithmic trading, automated trading and high frequency trading interchangeably. But do all these terms imply the exact same thing? Let's understand the minor difference.

Algorithmic Trading - As explained in a previous post algo trading enables a trader to set instructions for a computer to buy or sell stocks when the defined conditions are met. Here the trading strategy follows an algorithm. The decision about trading operation is not taken by a computer. It is a human who decided at which point to buy or sell stocks. As long as the trading strategy follows an algorithm, it is labeled as 'algo trading' whether the execution part is being performed by a human or a computer (automatically). Hence, automation is limited to the trade-order execution part in algo trading.

But that is not everything a computer can be used for in trading business. There are
algorithms that are capable of making an investment decision and this is where
automated trading comes in.

AutomatedTrading -It is often
confused with algorithmic trading. Automated Trading is the absolute automation of the trading process. Here decisions about buying and selling are also taken by computer programs. This means the order is automatically created, submitted (to the market) and executed. The automated trading facility is usually utilized by hedge funds that utilize proprietary execution algorithms and trade via Direct-Market Access (DMA) or sponsored access..

High-frequency
Trading (HFT) - Itis a subset of automated trading. Technology has made it possible to execute a very large number of orders within seconds. Such speedy trades can last for milliseconds or less. HFT firms earn by trading a really large volume of trades. Clearly speed of execution is priority here and HFT uses of direct market access to reduce the execution time for transactions.

In short,
Algorithmic Trading is basically an execution process based on a written algorithm, Automated
Trading does the same job that its name implies and HFT refers to a specific type of ultra-fast
automated trading. I hope this post helped you understand these terms more clearly. Please free to drop a comment. Cheers!

Tuesday, March 8, 2016

Today stocks are traded electronically. Even programmed trading has become a popular way to trade stocks more frequently. But there was a time when actual stock certificates were traded instead of their electronic form which is very common today. By the time I started trading the electronic trading had become the most popular way to trade stocks. If you are like me, have you ever wondered what was it like to trade before dematerilization?

I got a chance to learn about experience of an Indian stock trader who was a regular trader when physical stock certificates were used. Here's what I learnt -

Stock exchanges used to appoint people to display stock prices.

There were employees appointed by exchanges to watch trading activities.

Changes in stock prices were not as frequent as we see now a days. On an average prices used to change after every 15 minutes.

Just like today the movement in stock prices used to depend on script or market volatility.

All the restaurants near major stock exchanges used to be full.

There used to be a speaker device in stock exchanges and offices of brokers. Announcers used to announce prices of the most traded stocks continuously.

It was possible to know that which stock is being bought by which operator.

Markets were full of gossip mongers and a lot of insider information was available to people back then which is not the case now a days.

Future & Option trading was not there but there was Carry Forward trading.